04 February 2010

Economics Bloggers On Tweaking Taxes

Gasoline taxes make more sense as a way to fund roads than general fund revenues, since they act as a rough justice user's fee. Gasoline taxes also encourage conservation of a scarce resource, while at the same time discouraging air pollution. And, every nation in the world other than the United States taxes gasoline at rates far higher than we do. U.S. gasoline taxes have also gone down in inflation adjusted terms, because U.S. gasoline taxes are calculated on a cents per gallon, rather than a percentage of total price basis. As a result, gasoline tax revenues have not kept pace with the rising costs of maintaining our roads and bridges.

Carbon taxes are taxes on fossil fuels designed to reduce air pollution that are based on anticipated carbon emissions from a given amount of fossil fuel consumption. Some proposals would include a gasoline tax, others would tax fossil fuels other than gasoline on the theory that gasoline is already taxed. A carbon tax would increase utility bills, would encourage homeowners who use heating oil (still widely used in the Northeast) to switch to natural gas, and would encourage utility companies to generate electricity with natural gas, renewable energy sources and nuclear power rather than coal. Increased awareness of the public health and climate change risks associated with excess air pollution probably makes the purpose behind these taxes more popular.

Carbon taxes also have the virtue of being easier for companies to plan in response to, and easier to administer, than alternatives like cap and trade markets in rights to pollute, and don't have a built in bias in favor of existing polluters. But, unlike cap and trade policies, they force governments trying to meet treaty obligations on overall emissions levels to make predictions on the impact that carbon taxes will have on behavior that have the potential to be wildly off the mark. In a cap and trade regime, the determination of the actual effective tax rate on carbon emissions is set by the marketplace rather than by government economists. This is less of a concern in the gasoline tax area, where gasoline consumption's responsiveness to price is better understood and raising revenue rather than modifying behavior is the primary objective.

Carbon taxes, or cap and trade systems, however designed, favor manufacturing in states like California, Oregon and Washington that have quite green energy sources, over manufacturing in states that do not.

Gasoline taxes and carbon taxes also secure more support because they are primarily microeconomic rather than macroeconomic tools. There is much greater consensus among economists about their discipline's microeconomic conclusions than there is about their discipline's macroeconomic conclusions which are currently rather battered in the wake of a massive collective failure of mainstream macroeconomics to predict the financial crisis or sound the alarm on the need for regulatory action to mute it.

Customs Duties

Customs duties (i.e. taxes on imports) are not popular with economics bloggers who generally favor free trade over protectionism and mercantalist trade policies. Economists have disliked customs duties since the days of Adam Smith and can hardly be expected to change their views now. The argument in favor of customs duties is that they can compensate for taxes that domestic producers have to pay that importers avoid in tax regimes where retail sales taxes (that treat domestic and imported products the same) are not the dominant source of government revenue.

It would be interesting to see if customs duties would receive a warmer response if they were imposed only on countries that have weak environmental laws or poor protections for workers or large government crop subsidies, as a tool of diplomacy to discourage this kind of race to the bottom that creates an uneven playing field in the world economy.

This case could be particularly strong politically if it was possible to make credible consensus estimates of the impact that these laws have on import prices. For example, a tax could be imposed on imports, in lieu of a carbon tax, based upon the estimated carbon emissions involved in producing those goods in a particular country. This would have the practical effect of making imports from countries like China, which has an economy heavily reliant on coal, considerably less competitive relative to domestic goods which tend to be produced with cleaner energy sources. Goods certified to be produced with green methods or upon which domestic carbon taxes had already been paid might be exempted from this kind of customs duty or entitled to a credit against them.

Since we mostly import goods rather than services from high pollution countries, a customs duty in lieu of a carbon tax would provide the most economic benefit to places where manufacturing is most important, the Rust Belt, and the less widely known "New Rust Belt" in Appalachia. It would have a much smaller effect on imports of high end goods from the developed world, where pollution controls are strong, than it would on imports of low end goods from the second world, where pollution controls tend to be weaker and manufacturing activity is great.

Labor unions have made level playing field arguments in vague terms, but have failed to get much traction politically, except in cases where foreign competitors are selling products at below cost in an effort to wipe out U.S. industries in the long run. But, outside this very narrow context, the imposition of customs duties simply to protect a domestic industry without a more widely relevant justification looks like pure special interest lobbying that has gained neither academic nor popular support.

International treaties like NAFTA and GATT as administered by the WTO also limit the ability of lawmakers to use customs duties in these ways.

The United States is such a large market that it could be quite effective if it used this tool, and would be even more effective if it did so in concert with the European Union, which is a single entity for customs duty purposes.

Big Picture Tax Policy

About half of economics bloggers favor a "flatter" (i.e. less progressive but not regressive) tax burden, about a quarter favor greater progressivity (i.e. tax the rich more), and about a quarter like the status quo. I would note that the status quo of federal, state and local taxes combined is very close to flat, despite a common perception to the contrary, mostly as a result of a tendency to focus on federal income taxation in isolation. Those who favor a "flatter" tax policy either really favor more regressive taxation or don't realize how close to their goal we already are now.

Economics bloggers tend to favor a shift towards consumption taxes and away from income taxes (particularly corporate income taxes). There is an even stronger consensus among economics bloggers that payroll taxes are too high.

The main difference between consumption taxes and income taxes is that consumption taxes don't tax investment income and tax money that is saved only when it is withdrawn and spent, while income taxes, in theory, tax income when it is earned.

In practice, the difference between consumption taxes and income taxes is not as great as it appears. A panopoly of tax breaks for investments mean that the income tax burden on unearned income is much lighter than the income tax burden on earned income at all income levels, and taxation on income that is saved can often be deferred through, for example, retirement accounts, education savings accounts, health savings accounts, and reinvestment of capital gains.

The strong preference for consumption taxes over payroll taxes is also a bit of a mystery. Both are generally imposed at flat rates. Both generally leave investments untaxed. Differences in the ways that high and low income people make income and spend their income, in practice, make many of the theoretical differences between consumption taxes and payroll taxes smaller than they appear. In practice, both kinds of taxes are moderately regressive. And, both involve low administrative costs and relatively low levels of tax evasion compared to more complex income tax regimes.

Also, payroll taxes are generally ear marked for transfer payment programs. For those on the right, this provides a limtation on goverment mismanagement of money, and most economists see taxes that fund transfer payments as close to economically neutral. For those on the left, it is worth noting that most of the regressivity in payroll taxation is offset by progressivity in the programs funded with payroll taxes like Social Security, Medicare and unemployment insurance. In contrast, revenues from consumption taxes, both retail sales taxes and value added taxes, are generally used for general fund expenditures.

It could be that economics bloggers see virtue in taxing people who cash out their investment income (which payroll taxes do not). But, since lower income people don't generally have much investment income period, and higher income people tend to save a larger share of their income, this theoretical distinction isn't as meaningful as it appears. It could also be that the combined package of consumption taxes and general fund spending is more regressive than the combined package of payroll taxes and transfer payments, and that overall conservative leaning economics bloggers tend to favor the former.

The stark divide in attitudes in the economics blogging towards consumption and payroll taxes is further evidence in my view that economics remains a field heavy on ideology and theory, and weak on empirical evidence.

Questions Not Asked

A couple important questions about tax policy weren't asked, but are worth mentioning.

Tax Base v. Tax Rates

It is clear that no one is going to repeal the income tax, as governments need that revenue and replacement of the income tax with a consumption tax is politically impossible. The more realistic question that is policy makers face regularly is whether it is better to broaden the income tax base to keep income tax rates lower, or whether it is better to use income tax breaks in the hope of supporting economic growth while leaving income tax rates higher.

Good government types and "mainstream" economists tend to argue for a broad tax base that takes government out of economic decision making. But, there is never a shortage of economists making their way to Gucci Gulch to argue that particular base narrowing tax breaks would be good for the economy. Base broadening tax reforms, like the 1986 revision of the federal income tax, and the current legislation in Colorado to repeal or suspect sales tax exemptions, are the rare exception and tend not to be long lived.

Corporate Income Taxes v. Publicly Held Security Taxes

Another question it would be interesting to hear the opinions of economics bloggers on is the proposal to replace corporate income taxes (which they don't like very much) on a revenue neutral basis with a property tax on the market value of a corporation's public held securities.

A tax on the market value of publicly held securities doesn't pose nearly as many incentive and tax administration issues as a proposed tax on trades in securities. A tax on publicly held securities could raise as much revenue as the current corporate income tax with considerably less administrative cost for both the government and the taxed corporations. A tax on publicly held securities doesn't favor debt over equity as current corporate income taxes do with a strong negative effect on the robustness of our big business sector during downturns. And, developments like the S corporation, the limited liability company and the device of paying owner-operators of C corporations large bonuses, mean that privately held companies almost never pay corporate income taxes anyway. The existing corporate income tax has also been roundly criticized in academic and theoretical circles for constituting "double taxation" and in the popular press for its inability to collect revenue even from large publicly held companies with large profits from a financial accounting perspective. Property taxes, generally, also have the effect of having a zero percent marginal tax rate on additional income (although changes in market value in response to earnings changes would probably mute this effect).

Companies that don't want to pay a tax on publicly held securities, which may have difficulty doing so because they are growth companies with low earnings and high market value, can also delay going public, or be financed with private equity and ordinary business loans rather than publicly offered bonds.

Since publicly held securities are disproportionately owned by the affluent, the incidence of the tax would probably be quite progressive, but it might not be that different in incidence than existing corporate income taxes. Most investors have diversified porfolios of publicly traded investments so big differences in the amount of tax due from individual companies might not have much of an impact on the investors who own them.